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Make the right choice… stocks, bonds, gold, or commodities

Here’s a question I (Porter) bet you’ve never asked yourself…

“Why am I buying stocks?”

If you’re an individual investor, chances are good that most of your liquid wealth is allocated to common stocks.

You’re also probably diversified, in at least some way, into derivatives of common stocks, too. Most investors own derivatives like exchange-traded funds (ETFs), mutual funds, or pension funds that invest in stocks. These “helpers,” as legendary investor Warren Buffett calls them, give investors peace of mind… for a fee. What they almost never do is increase actual returns in excess of the fees and taxes they incur.

But let’s not quibble about whether or not investing in stocks directly or through ETFs and funds is best. Let’s ask the much bigger question… the question that virtually everyone takes for granted…

Should you invest in stocks at all?

If not, what should you buy instead? What could possibly offer you stock-like returns (or better) and still be completely passive and relatively safe?

First, let me admit a bias…

I don’t believe it’s possible to make better and safer passive investment returns than through buying the highest-quality capital-efficient businesses and holding them for the long term.

The steady dividend increases that these investments will produce over several decades are virtually impossible to beat through any other investment system or strategy. Earning 12%-15% a year in these kinds of businesses… for 20 or 30 years… while reinvesting your dividends… will generate significant amounts of wealth. There’s probably no better, surer, or safer way to become wealthy. That’s why at least some of your portfolio should always be invested in common stocks.

But probably not as much as you think.

There’s a big catch to stock investing…

Few companies will perform as well as they should for the long term. Most public companies are poorly run. They’re the opposite of capital-efficient, with management teams that destroy capital, reduce dividends, and render billions in losses to investors.

Investors in General Electric (GE), for example, might have thought they owned one of the world’s greatest businesses. (We warned them to the contrary.) But GE’s investors have lost almost $500 billion since the early 2000s. And that’s just the most notorious example. Most public companies are woefully managed and will ultimately fail.

It’s not easy to sort the best from the rest. Owning just one of these big failures for a long time can wipe out all of your other gains. That’s one excellent reason to avoid buying stocks altogether: they are extremely volatile.

What could you buy instead? Well, let’s look at the numbers…

We recently completed a thorough study of investment returns and volatility from 1991 through today. We picked the time period at random – it’s as far back as we have reliable data for one of our indexes.

Personally, I think looking back at the last 27 years is an important “lens.” This fairly modern period has seen the impact of global central banking and radical changes to both global trade and technology.

Obviously, the future could be a heck of a lot different than the last 27 years, but this period is far more applicable to understanding current financial trends than studying what happened under the gold reserve system that existed from the end of World War II until 1971.

Undoubtedly, stocks, as measured by an S&P 500 index fund, have been great for investors…

Since 1991, stocks have earned investors about 8% a year. But those returns have come at the “expense” of extreme volatility (16.2%). Even the most conservative investors (like Buffett) have seen portfolio declines of 50% or more multiple times in the last 27 years. It’s difficult (or even impossible) for retired investors or folks with relatively small incomes to face this kind of volatility.

Stocks are simply not a good financial tool for most people. They’re risky. They’re hard to understand. And you can lose a fortune if you buy the wrong ones or if you panic and sell them at the wrong time.

If you haven’t done well with stocks and these problems sound familiar, don’t worry…

You could have made a worse choice: gold.

Gold has generated about half the return of stocks (4.4%) but has almost the same amount of volatility (15.6%). If you don’t want to make any money and you enjoy seeing your portfolio balance collapse on a regular basis, gold is the right choice for you.

Buying gold is a lot like going to a bar and asking for a beer. When the bartender says, “All we have left is a stale, flat keg… But at least it’s warm,” the gold bug replies, “Better make it a double.”

Now… here’s the real irony. I’ve been buying gold bullion for almost 20 years. And I’ve never sold a single coin. I don’t care what the price of gold is – I care about how many coins I own. And I’d like to own more, not less.

My point is, there are a lot of good reasons to buy gold that go far beyond portfolio management. I own gold as a crisis hedge and as the ultimate form of savings. But as you’ll see… gold also should play an important role in your portfolio, too, despite its poor overall performance.

So if you aren’t going to own stocks (because they’re extremely volatile) and you aren’t going to own gold (because it’s extremely volatile and offers low returns), then I suppose you should buy bonds… right?

That’s exactly right. Since 1991, bonds have gone up almost 7% per year and have experienced extraordinarily low volatility. Bonds have about 75% less volatility than stocks and trail their annual returns only by about 1.5 percentage points. In short, if you’re willing to give up a small amount of annual returns (roughly what your investment managers are probably charging you), you can do well by investing in safe bonds.

In fact, the ‘real life’ returns for bond investors are likely much better than these numbers suggest…

You see, to measure the long-term returns of the U.S. corporate-bond market, we’re using a Merrill Lynch total return index that measures returns from investment-grade bonds.

We’ve proven in my Stansberry’s Credit Opportunities service that buying non-investment-grade bonds at a discount can deliver annual returns of 20% or more. (Right now, the average annual return on our 15 closed positions is 33%.) Even though there isn’t a good long-term index that shows what the returns would have been for wisely allocating between investment-grade and non-investment-grade bonds, achieving better results than stocks is easily possible, with less than half the risk.

That’s why I tell our subscribers that most individual investors shouldn’t buy stocks at all. They should only buy bonds. (I’ll make an exception for our highest-quality, capital-efficient stock recommendations.)

Well, that’s it then… We have our answer, don’t we?

Forget about stocks. Just read Stansberry’s Credit Opportunities and keep a sensible mix between investment-grade and non-investment-grade positions. Over time, you’ll beat the stock market’s returns. And you’ll take a lot less risk.

That has certainly been true. And it might be true going forward. But the bond market has been in the biggest bull market of all time since the early 1980s. During this study’s measurement period, the average interest rate on investment-grade debt dropped from more than 10% to less than 4%. As bond yields fell, bond prices soared. It’s hard to imagine that the next 25 or 30 years will see anything like these kinds of returns in bonds again. It’s almost impossible, in fact, because of the zero-boundary for interest rates.

And that puts a big wrinkle in our conclusion.

But what if there was a safer way to own bonds? Or what if there was an investment allocation you could make that was even better in some ways than bonds… and stocks… and gold?

Well, there is…

The portfolio allocation choice we haven’t mentioned yet is commodities…

Commodities are more or less a dirty word for most investors today because stocks have trounced them for so many years in a row. And of course, most of the time, stocks outperform commodities by a wide margin. That has been especially true over the last several decades as technology has played a big role in both reducing the cost of producing commodities and increasing commodity production.

Yes, all of that is true… And it’s likely to be true for years to come. But there’s still a reliable way to make money in commodities. It’s called “backwardation.” It’s a foundational principle of economics that people are willing to pay more for something today than they will to get it tomorrow. Buying commodities for delivery in the future usually costs less than buying them today in the “spot” market. The difference in today’s price and tomorrow’s price can be locked in with futures contracts, yielding a reasonable profit.

Commodity-hedging firms make their living doing this… And now, there’s a reasonable way for you to do it, too. (More about that in a minute.)

The other well-established way to make money in commodities is through simply following trends…

You might not want to own grains or metals or pork bellies for the long term, but owning them in the early stages of a supply disruption can quickly make you a fortune.

What if, for more than 25 years, you had followed these two proven strategies in commodities? You took half your portfolio and bought the seven (out of 27) major commodity futures contracts that had gone up the most over the previous 12 months, and you bought the seven other contracts that offered you the largest monthly return based on backwardation?

An index tracks this specific commodity investment strategy. It’s called the SummerHaven Dynamic Commodity Index (or “SDCI,” for short). An ETF now follows this specific strategy, too – the U.S. Commodity Index Fund (USCI), so it’s possible for individual investors to follow this strategy. Over the period of our study, the SDCI earned investors a lot more than stocks (more than 10% a year) but had less volatility.

The table below summarizes our research…

If you’re only going to own either stocks, bonds, gold, or commodities, there’s a clear winner: commodities. Of course, that’s only if you’re investing in them in the right way, by maximizing the returns available through backwardation and following the biggest trends. Buying and holding commodities doesn’t work.

Looking at the data, it occurred to me that owning a 100% commodity portfolio would still be too volatile for most investors. Even though the returns are higher, the volatility in commodities (as measured by SDCI) was still almost as high as stocks. And knowing that bonds are less volatile, I figured that adding in some bonds would reduce the portfolio volatility. But looking forward, I’m worried that bonds won’t perform well. What do I think is going to perform well during the next bear market in stocks? Gold.

I asked our staff to look at building a ‘dumb’ portfolio…

It would have a 50% allocation to commodities (via SDCI) and a 50% allocation to either bonds or bonds and gold, depending on whether gold was trending higher. (We defined a gold uptrend as any period where the 90-day moving average was higher than the 300-day moving average.)

Thus, this portfolio would either be 50% commodities and 50% bonds… or 50% commodities, 25% bonds, and 25% gold.

The results were terrific.

Gold is a great hedge against the bond market, if you only own it when it’s trending higher. This portfolio – made up of commodities, bonds, and gold – generated annual returns greater than stocks (9%), with a volatility that was about half of stocks (8.7%). It generated returns that were 50% higher than bonds alone, too, which more than compensates you for the increase in volatility.

What’s interesting to me about this research is that our subscribers almost universally own stocks and avoid commodities. And yet, it turns out that this portfolio, which excludes stocks and is heavily allocated to commodities offers vastly better risk-adjusted returns.

One of my personal goals in this business is to convince as many people as I can that there’s a better way to invest…

Yes, stocks can be part of that solution – provided that you’re willing to be conservative and to adopt at least some of our risk-management tools. But the next level is to think about what (beyond stocks) can help you achieve your investment goals with the least amount of risk.

In that regard, I’m certain that adding bonds, commodities, and gold to your portfolio – and in the right way – can be incredibly helpful. I hope you’ll consider doing so.

Of course, we now offer research to help you do this on your own. And I’m certain that our research products can help you produce returns that are better than the indexes. Just look at the track records of Stansberry’s Credit Opportunities and Stansberry Gold & Silver Investor…

Going forward, I expect the same kind of results for Steve Sjuggerud’s latest project, True Wealth Opportunities: Commodities. (You can learn how to become a charter member at a steep discount to what it will eventually retail for by clicking here.

But whether you follow our advice or you buy ETFs and index funds for your allocations, you should definitely consider this approach to wealth management… And you should make these changes right now. Stocks won’t trounce gold and commodities forever.

This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Stansberry Research, LLC. 1125 N Charles St, Baltimore, MD 21201
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